Auvila Quick Note (SRE; 6/28/2018): SRE Analyst Day: If SRE didn’t deliver KO blow to AI then it’s a TKO win

Elliott Management & Bluescape Energy Partners (together Activist Investors (AI)) proposed breakup of SRE into 4 parts: Utilities, LNG/Midstream, Mexico/Lat Am, and sale of renewable portfolio
We oppose this strategy, and management delivered measured but decisive rebuttal of AI proposal, in our opinion
Unlike AI’s understanding of SRE’s strategy, it is not about building a power market conglomerate but about taking advantage of the natural gas value chain, which, in our opinion, SRE is doing very well
Also, outside of the LNG business, none of the other businesses are dependent on Utilities funding its operations, and management had already decided to sell SRE’s renewable portfolio which necessitated a write-down of some $0.9B
SRE vigorously defended keeping LNG facilities and iEnova in Mexico, which we adamantly support
SRE noted that neither of its foreign businesses depend on external financing, another misunderstanding by the AI, and noted that Cameron LNG trains 1-3 would spinoff some $12B in future cash flow, after debt service
SRE also noted that Total (French major oil company) is looking to invest in Cameron 4&5 and others, including KoGas, may be interested in taking equity position in ECA liquefaction
With regards to CA wildfires, SRE is in-line with PCG and EIX in their view that inverse condemnation must go
SRE noted that over 2018-2020 period, it has some $15B of investments lined-up with upside potential that would deliver some 20% CAGR in earnings, 13% CAGR in EPS, 8% CAGR in dividends, and continued parent debt reduction; post 2020, SRE estimates potential investment opportunity of some $24B, much of it geared towards the development LNG projects
Conclusion: We strongly believe that AI are dead-wrong starting with their general understanding of SRE’s overall strategy. Therefore, … .

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Auvila Flash on SRE (06/11/2018): If reported correctly, Elliott Management and Bluescape Energy Partners proposed restructuring is off-target, in our opinion

Facts

Elliott Management and Bluescape Energy Partners (AI: Activist Investors) acquired some 4.9% of SRE or some $1.3B according to CNBC
In a letter sent to SRE’s management and board of directors, which the company confirmed, CNBC is reporting that the AI believe the reason for SRE’s underperformance despite the stable of valuable assets is because of the complex strategy and diffused focus
It is proposing to restructure the company by breaking it apart into at least three pieces:
Keeping the California utilities and its Texas Utility (formerly Oncor) together;
Packaging its LNG and Midstream businesses together as a second company; and
Divesting, the renewable energy business, iEnova (Mexican energy infrastructure company), and its South American utilities businesses
Revamping the compensation system to more align management incentive with shareholder value creation
By doing so, the AI believe they could push SRE’s stock price to between some $139-$158 per share
The AI supposedly describes SRE’s strategy as a failure to build a power market conglomerate
The AI successfully steered NRG towards a successful strategy and helped management better realize the potential of NRG’s assets, which we strongly supported
The AI also believe that SRE is cannibalizing Utility cash flow to fund other projects — implication is that this is a waste of shareholder capital

Analysis

If as CNBC states that the AI believe that SRE’s strategy is a failure to build a power market conglomerate then it tells us that the AI missed the main point of SRE’s strategy

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SRE 1Q2018 Earnings (05/07/2018): With Oncor closed, we look for flourishing Twin Towers strategy

With Oncor closed, we look for SRE to increase M&A and investment in TX/Gulf-Coast: Committed to $7.5B-up-to-$8.4B utility capital spending thru 2022; other than generation and R&M nothing seems prohibited, especially if it has Mexico component
2018E AEPS guidance remains unchanged at $5.30-$5.80/share
SRE is expected to grow dividend 8%-9% to match
2019 GRC filed 10/2017 w/FD expected late-2018/early-2019
We look for SRE to outperform guidance in ST, MT and LT
Within next 12-months we look for Cameron 4&5 to get FID and begin construction; ECA liquefaction also seems likely. Even Port Arthur seems likely, given MOU with KoGas.
SRE looking at asset sales potential and looks to repatriate some $1.6B from 2018-2022 w/immaterial tax expense
IEnova announced liquids terminal project; it has billions in potential opportunities
We support SDG&E’s move towards energy storage and more renewables, and SCG’s continuing emphasis on pipeline safety and reliability
Potential for LNG-to-power projects in oil- and coal-fired dominant regions like Central and South America and even Hawaii could be another future growth source

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Auvila Flash SRE (03/07/2018): SRE 2018E AEPS Guidance — We made a mistake in our assumption

SRE’s estimate for Oncor’s 2018E net income: $430MM
SRE’s interest in Oncor: 80%
SRE’s estimated 2018 annual share of net income: $344MM
Assume March 15, 2018 closing of Oncor acquisition
SRE’s estimated 2018 actual share of Oncor’s net income: $272.3MM (19/24ths)
Annual Interest Expense on $5,000MM financing at an average interest rate of 3.185%: $125.8MM
2018 Interest Expense on $5,000MM financing: $120.6MM (assuming 23/24ths of annual interest expense)
Annual Preferred Dividend on $1,725MM financing at the coupon rate of 6%: $103.5MM
2018 Preferred Dividend on $1,725MM financing: $99.2MM (assuming 23/24ths of annual interest expense)
Assumed share count for 2018: 275MM

($272.3MM – $120.6MM – $99.2MM) / 275MM = $0.19/share

We made the incorrect assumption that the reduction in corporate tax rate would accrue to the benefit of shareholders for 2018, and we incorrectly took SRE’s share of Oncor’s ANNUAL net income then subtracted interest expense and preferred dividend then multiplyed the result by 75% instead of starting with 75% of SRE’s share of Oncor’s annual net income.

Again, we apologize for the mistake.

Regardless, we feel strongly that SRE will outperform its 2018 guidance of $5.30-$5.80/share, and we’re not convinced that our 2018 estimate for SRE of $5.95 is necessarily incorrect. Therefore, we wait for quarterly results to start flowing before we make any adjustments to our estimates.

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SRE 4Q2017 Earnings (02/27/2018): Oncor ready to close by 1Q18 end; Future prospects bright

With Oncor close, we look for SRE to increase acquisition and investment in TX/Gulf-Coast: Committed to $7.5B-up-to-$8.4B utility capital spending thru 2022
2018E AEPS guiding to $5.30-$5.80/share; mid-point’s slightly higher than our prior estimate, but too low given 2017A Oncor results
SRE is expected to grow dividend 8%-9% to match
2019 GRC filed 10/2017 w/FD expected late-2018/early-2019
Within next 12-months we look for Cameron 4&5 to get FID and begin construction; ECA liquefaction also seems likely. Even Port Arthur seems likely, given MOU with KoGas
SRE looking at asset sales potential and looks to repatriate some $1.6B from 2018-2022 w/immaterial tax expense
IEnova’s has billions in potential opportunities; we support SDG&E’s move towards energy storage and more renewables, and SCG’s continuing emphasis on pipeline safety and reliability

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2018 Industry Update: Economic growth should favor commodities-driven businesses in 2018

Warmer than normal winter:
Weak gas prices:
However, 4Q2017 and 1Q2018 power gross profit could be better than expectations:
Similarly, we’d expect natural gas infrastructure businesses to perform well for 4Q2017 and 1Q2018:
We expect economic growth to surpass 4% for 2018:
Strong economic performance should lead to strong power sector performance:
Commensurately, we expect natural gas infrastructure businesses to perform well:
Adjusted for seasonality, we expect natural gas prices to creep up throughout 2018 and, given normal weather, we’d expect natural gas prices to average at or just below $3.50 for 2018 with an exit price of some $3.65-$3.75:
Conclusion: Going into 2018, we believe that natural gas prices will stage a moderate recovery, but power margins should do better benefiting from accelerating economic activity. Individually, we continue to like… . However, the real star may be … . Among the utility names, we like … due to their growth prospects. We also look for … to outperform as … .

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GOP Tax Bill is win for utilities, power, infrastructure, and customers

GOP Tax Bill (GOPTB) looks to be positive for industries and companies in our coverage universe
Key aspects of GOPTB that affect our coverage industries and companies include, but not limited to:
21% corporate tax rate would be expected to reduce deferred income tax liability by some 40%
Interest expense deductibility capped at 30% of EBITDA for 2018-2021 and to 30% of EBIT after
100% investment deduction, except for utilities that would continue to deduct 100% interest
Preservation of existing investment tax credits (ITC) and production tax credits (PTC)
Repatriation of profits tax at 15.5% for cash and equivalent and 8% for non-liquid assets
Base-erosion & Anti-abuse Tax (BEAT) not impactful: If payments to foreign affiliates are 3% or more of a large company’s tax deductions then BEAT is imposed. We do not view this as relevant to companies that we cover, given 100% of PTC would be allowed to offset up to 80% of BEAT
AES Corp. faces large disqualification of interest expense deductibility but given its $3.7B in NOLs, we do not believe this to be an immediate issue; AES has time to remedy the situation:
NRG Energy shouldn’t have any issues with interest expense deductibility:
Exelon Corp. isn’t expected to have any problems with interest expense deductibility:
Cheniere Energy, oddly enough, shouldn’t have any problems with interest expense deductibility:
BKH, CNP, DUK, EIX, PCG, PNM, SRE should not have any issues with interest expense deductibility but may be able to use 100% investment deductibility to create win-win:
We note that the inability to deduct interest expense is limited to $0.21/$1 of lost deductibility
Loss of interest expense deduction could lead to some unexpected corporate behavior

Conclusion: Net effect of GOPTB looks to be positive, more so if utility holding companies are permitted to use non-utility subs to take advantage of the 100% capital investment deduction

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SRE 3Q2017: New Strategy Takes Shape with Oncor; New Projects Increase NIV

We look for SRE to increase acquisition and investments activities in TX/Gulf-Coast areas. Other than generation, R&M nothing seems prohibited, especially if it has Mexico component
Guiding towards upperend of $5-$5.30/share 2017 AEPS guidance
2020 AEPS guidance of $7.20-$7.80 seems low – only some 12% CAGR from 2016A AEPS. SRE is expected to grow dividends 8%-9% to match
2018 GRC filed 10/2017 w/FD expected late-2018/early-2019
We look for outperformance with regards to SRE’s guidance in ST, MT and LT
Within next 12-months we look for Cameron 4&5 to get FID and begin construction
NIV/share moves up to $230/share from $210/share on 2017 performance and additions of new capital projects

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SRE: Details on financing given; Oncor deal looks to remain on track for 1H18 close

Expected 2018E AEPS accretion of $0.15-$0.25/share, which is in line with our expectations (please see the first Table 1 below)
SRE intends to own 100% of Energy Future Holdings (If realized SRE would own approximately 80% of Oncor and TTI would own the balance of 20%) after $3.0B debt at the holding company is paid-off, which we expect to occur within 7 years
Equity issue of some 50%-65% of SRE’s equity commitment, which is about $3.87B (60% of $6.45B)

Balance of the equity commitment is going to come from a combination of cash and debt, likely more debt in our opinion, given the plethora of projects that SRE needs to fund
Still searching for 40% equity commitment for transaction or about $2.58B of third-party equity investment: Looking for long-term strategic partner with about a 7 year investment horizon
Based on $7.5B five-year investment program at Oncor, SRE expects CAGR in net income to be some 6%-7% through 2022
SRE states 100% valuation for Oncor based on $18.8B EV
Deal expected to close in 1H2018

Conclusion: The more we study and hear about this deal, the more we like it.

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